Regulating financial benchmarks: Creating the right balance

March 4, 2013

Harry Lipman, Global Product Manager of Bloomberg’s OTC Derivatives participated in a panel discussion about the future of global financial benchmarks, a topic that greatly impacts the trust and confidence of financial markets worldwide. The panel was held recently at the Securities Industry and Financial Markets Association (SIFMA), moderated by Martin Dickson, US Managing Editor of the Financial Times.

Below is a blog post from Harry about the event:

Financial benchmarks determine payments on and set prices for at least $750 trillion worth of financial products, including mortgages, student loans, and credit derivatives.

Achieving the appropriate balance to regulate financial benchmarks is crucial, as it will have a significant impact on the markets globally. It’s vital that they are developed with a strong, consistent, and transparent design that creates a level playing field for all.

There are three key areas that we feel should be addressed: (1) Creating non-discriminatory access; (2) Avoiding monopolies via exclusive licenses; and (3) Ensuring that constituent and weighting information is available to all key participants.

Industry benchmarks must be accessible on fair, non-discriminatory, and reasonable terms. European regulators recognize the importance of this issue and are addressing it in their financial reform legislation.

One significant problem we are seeing in the marketplace is the granting of exclusive licenses for benchmarks. Such arrangements can lead to a monopoly and restrict who can create financial products, which works against natural market competition.

We believe that regulated non-discriminatory access to benchmarks must include access to constituent and weighting information. While some benchmark providers are demanding higher fees and restrictions on this information, this must be balanced against the critical role that this information plays in market transparency, especially in times of market uncertainty. While we understand that the choice of constituent/index weightings may be strongly driven by the market-makers, as they incur the market making risks, hedging, and liquidity issues, we also believe that there must be clear access to this information and the methodology for choosing it needs to be transparent.

Finally, we are disappointed by one aspect of the framework proposed by Martin Wheatley of the UK’s Financial Services Authority which permitted access to individual Libor constituent bank contributions to be publicly delayed three months. This would represent a major step backward in transparency.

Benchmarks do not exist in a vacuum. In transparent markets, there is more likely to be the raw materials necessary to provide a verifier or a deeper understanding of existing benchmarks. In non-transparent markets, that opportunity doesn’t exist.

For example, Dodd-Frank created a new regime for swaps trading, the Swap Execution Facilities (SEF) regime. Like existing futures exchanges, these SEFs would be centrally cleared. However, SEFs were designed to be more transparent than futures exchanges. All SEF trading was to be reported to a Swap Data Repository which would make the data available to the public for free in real-time.

Unfortunately, the establishment of much higher margins for swaps than futures – even where the products are identical or have the same risk profile – will drive much of this trading from transparent SEFs to less transparent futures exchanges.

While that clearly reduces transparency in the derivatives space, it also means there is less data available for testing the validity of benchmarks outside of the derivatives space. For example, derivatives data reported to a Swap Data Repository would be instantly available as a material input to help analyze the creditworthiness of a bank. As trading is driven to less transparent venues, we are forced to rely upon a bank’s subjective assessment of creditworthiness as reflected in estimated lending rates – as in LIBOR.